On Money as a Medium of Exchange

Nobuhiro Kiyotaki, Randall Wright

Journal of Political Economy · 1989 · 1.4K citations · 15 references

Concepts

TL;DR

Certain goods can endogenously become media of exchange, with commodity money arising from intrinsic properties and beliefs, while equilibria also allow fiat currency, and the analysis discusses velocity, acceptability, and liquidity. The study analyzes economies where individuals specialize in consumption and production and meet randomly, implying trade must be bilateral and quid pro quo. The authors model economies with specialized agents who meet randomly over time, forcing trade to be bilateral and quid pro quo. Nash equilibria in trading strategies are characterized, and the equilibria are generally not Pareto optimal, but introducing fiat currency into a commodity money economy can unambiguously improve welfare.

Abstract

We analyze economies in which individuals specialize in consumption and production and meet randomly over time in a way that implies that trade must be bilateral and quid pro quo. Nash equilibria in trading strategies are characterized. Certain goods emerge endogenously as media of exchange, or commodity money, depending both on their intrinsic properties and on extrinsic beliefs. There are also equilibria with genuine fiat currency circulating as the general medium of exchange. We find that equilibria are not generally Pareto optimal and that introducing fiat currency into a commodity money economy may unambiguously improve welfare. Velocity, acceptability, and liquidity are discussed.

References

15